China’s avalanche stokes fears of global recession

An avalanche of dollars exiting China threatens to smother all emerging markets (EMs), including India, and cause a global recession. Almost $ 600 billion have exited China in the last six months, a mammoth $100 billion per month.This would have emptied the forex reserves of almost any other country, but China still has $3.3 trillion left. However, it cannot afford a continuing outflow at this rate.

Its government placed curbs on stock markets to combat crashing values, but withdrew these when they proved ineffective. It is committed to making the yuan a reserve currency like the dollar. But this obliges it to allow capital to enter and exit reasonably freely, and hence risks further capital flight. For decades the Communist Party has firmly controlled the economy. But no more.

The Chinese avalanche has helped accelerate dollar outflows from all EMs (emerging markets). The Sensex is down from 30,000 to 24,400. The rupee has gone from Rs 62 to Rs 67.70 to the dollar. Yet India is the best EM performer: others are truly battered. Worse, the prices of oil and other commodities keep falling, a recessionary portent.

China has been slowing for two years. Pessimists like Ruchir Sharma of Morgan Stanley have long worried that total debt in China, induced by government stimuli, has shot up from 150% of GDP to 250%. History suggests that this will end in tears. The pessimists sneer at official Chinese figures showing almost 7% growth. Using alternative indicators like electricity consumption and rail freight, they argue that true growth could be just 4-5%.

However, optimists like Nicholas Lardy of the Peterson Institute say China is simply rebalancing its economy. Earlier, growth was driven by industrial exports and investment. But now China wants, correctly, to switch to an economy driven more by domestic consumption and services. This means slower GDP, but 6-7% growth is very respectable for an economy that in PPP terms is now the largest in the world. The optimists say indicators like rail freight and electricity may suggest slowing industry, but that is exactly what the Chinese government aims for by emphasizing services. So, the optimists say, there is no crisis, just sensible rebalancing.

Six months ago, one could take either view. But now the Chinese are voting for the pessimist’s version through capital flight. Individuals can remit $50,000 a year abroad. Some Chinese companies are investing abroad. But over half the outflow has a political explanation.

The fleeing billions are probably the ill-gotten gains of former Communist Party officials and their super-brats (often called “princelings”). They are being targeted by Communist Party chief Xi Jinping for corruption. Former security chief Zhou Yonkang and his colleagues have been arrested. Xi’s predecessor, Jiang Zemin, and his two sons have been placed “under control”, suggesting they may eventually be arrested. Xi is perhaps targeting the entire top leadership of the Jiang era. The resulting political struggle could have serious economic consequences.

Meanwhile Global Economic Prospects (GEP), the World Bank report on the world economy, has flagged the risk of a coming recession. The bank is too political (all its members are governments) to actually predict a recession. So, GEP forecasts world GDP growth rising from 2.4% in 2015 to 2.9% in 2016, and says the chances of a recession are low. But it then admits that EM growth has fallen below forecast levels for years. It says that if in 2016 the EMs underperform as much as in 2010-14, and if financial panic like the “taper tantrum” of summer 2013 recurs, then global growth could collapse to just 1.8%. This will be below the 2% widely used to benchmark a global recession.

Ultra-low interest rates in advanced economies have in recent years led trillions of dollars to flow to EMs in search of higher yields. A return to normal interest rates in advanced countries could induce a huge reverse flow out of EMs. That process seems to have begun with the raising of US interest rates.

In the 2000s, China accounted for half of all incremental world demand for commodities. Its slowing has caused the global demand for — and price of — commodities to collapse. Oil is now under $30/barrel, one-third of its rate in 2014. Commodity exporting economies are in dire straits. Brazil and Russia are in recession. Many Asian manufacturing economies are part of global value chains using China as an assembler, and have also been hard hit by China’s slowdown. India has been a resilient exception since it is a net commodity importer, and is not part of world value chains. But if the world falls into recession, India will be dragged down too.